When a Customer Deducts Penalties or Damages From Its Payment: What to Check Before You Agree a Figure

The invoice is due and you expected the full sum, but the amount that reached your account is smaller, with a short note: "penalty for late delivery and damages deducted". Some customers also send a reconciliation statement for you to sign. This is where business owners tend to decide too fast, either accepting quickly because they need the cash, or rejecting everything without checking what the customer is actually entitled to.

This guide helps you separate the matter into three parts before you discuss any figure. It follows on from preparing a response to a breach-of-contract allegation letter. If the whole balance is unpaid, see unpaid invoices from business customers. If the customer is holding back retention money, see contractor retention money not returned.

The short answer

Before agreeing any figure, separate (a) what the customer says you did wrong, and under which clause, (b) how much loss it actually suffered and what evidence it has, and (c) whether the contract gives it a right to deduct or claim in this way, subject to what conditions, caps and notices. Then reply in writing promptly, reserving your rights. Do not sign anything stating that payment is complete or that you waive claims until you have checked it all.

The law. Sections 341 and 342 of the Civil and Commercial Code allow set-off where two parties owe each other debts of the same kind that are due, by a declaration to the other side. Section 344 bars set-off of a claim that is still open to a defence. Penalties are in sections 379 to 383, including section 381 paragraph 3, on reserving the right when accepting performance, and section 383, on the court reducing a disproportionately high penalty. Actual damages are in section 222, and the customer's contribution to its own loss is in section 223.

Our practical view. Do not treat the deducted sum as one item. Break it into lines, because some may have a real basis, some have no evidence, and some may be disproportionate. Accepting only what is justified, while disputing the rest in writing, usually leaves you in a stronger position than accepting the whole amount to close the matter or rejecting everything and damaging the relationship. The final result still depends on the contract, the documents and the court's discretion.

The running hypothetical in this guide is a small rice mill and bagging business in Roi Et that supplies bagged rice to a large food distributor in Nakhon Ratchasima on monthly purchase orders. The latest invoice is 480,000 baht. The customer transferred 432,000 baht and said it had deducted 48,000 baht, made up of a late-delivery penalty of 30,000 baht and damages of 18,000 baht for damaged bags. We call the mill the "mill" and the distributor the "customer".

1. Can the customer deduct from its payment on its own?

In short, the contract may give it that right, or the law of set-off may support it, but the customer writing "deducted" does not make the deduction lawful.

Section 344 is the point to use. A customer who deducts a penalty for an allegation you reject may have deducted beyond its rights. But you must dispute it in writing, so it is clear from the start that the claim is genuinely contested and not something you raised only after taking the money. Note that whether a given defence is enough is a matter of fact and for the court, and you should not expect to win merely by citing this section.

Beyond the statute, check the contract and the purchase order for a clause allowing the customer to deduct penalties from the price. If there is one, it may bind you, but you still need to check whether the situation falls within its conditions, such as prior notice or a cap. If the documents conflict, for example the customer's purchase order against your quotation, see quotation and purchase order with conflicting terms.

2. Separate three things: the allegation, the evidence of loss and the contract terms

When the customer sends its figures, build a table with one row per deducted item and answer three questions.

A useful test is whether the customer's documents show all three. An item that has all three usually needs serious negotiation. An item missing one can be disputed, for example where the customer says delivery was late but its own warehouse delayed the receipt, or says the rice was damaged but has no photos or inspection report.

Also ask who confirmed the delivery, whether the delivery note carries the recipient's signature, and whether the customer reported the defects within the period set by the contract. If there is no receipt document, see customer not signing acceptance and you cannot invoice. If the contract is a monthly service agreement with service levels, see MSA and SLA monthly service contracts, since some contracts set out how service credits are calculated.

3. Penalty or damages: what is the difference?

A penalty is a sum the parties agree in advance that the debtor will pay if it fails to perform or performs improperly (section 379). Its advantage to the creditor is that it need not prove the loss in that amount. Damages must be proved as real loss caused by the alleged breach.

• Sections 380 and 381. The creditor may claim the penalty in place of performance, and if the penalty was agreed for defective or improper performance, it may claim both performance and the penalty.
• Section 381 paragraph 3. If the creditor has accepted performance, it can claim the penalty only if it reserved that right when accepting. Many customers miss this. If the customer received the goods and reserved nothing about the penalty, you have a point to argue. Check the documents from the time of receipt.
• Section 383. If the penalty is disproportionately high, the court may reduce it to a reasonable amount, considering every lawful interest of the creditor, not only its financial interest. Reduction is not certain, and you should not plan on the assumption that the court will reduce it.

Where there is no penalty clause, the customer has to claim damages. Section 222 allows damages that arise normally from the non-performance, and damages from special circumstances if the party liable foresaw or could have foreseen them. Under section 223, if the customer contributed to the loss, for instance by storing the rice improperly or by not reporting the problem early, the court may decide whether and how far compensation is due.

In the mill case, the 30,000 baht penalty must come from a penalty clause. The 18,000 baht for damaged rice needs evidence of the number of bags and the cause, not a number the customer estimated. So you can answer the two items differently.

4. How to reply in writing before agreeing a figure

Reply quickly and in writing, even if you keep negotiating by phone. A good letter does the following.

1. Confirms the amount actually received, with the date and the sum.
2. Notes what the customer alleges without admitting the allegation.
3. Disputes the deduction, stating that the matter remains in dispute and that you do not treat it as a valid set-off.
4. Requests documents item by item: the clause relied on, the evidence of loss and the method of calculation.
5. Reserves your rights over the unpaid part of the price, interest and other rights.
6. Sets a time limit for the customer to respond or pay.

Sample reply (adapt to your facts)

Re: Request for details and dispute of the deduction from invoice no. ____

Dear ____
Referring to invoice no. ____ dated ____ for 480,000 baht, we received 432,000 baht from you on ____
and understand that you deducted 48,000 baht as a late-delivery penalty and damages for damaged goods.

1) We do not accept that we are in breach as you allege, and we treat the deducted amount
   as in dispute. We do not accept that it is a valid set-off.
2) Please send within ____ days: the clause you rely on, the delivery deadline you apply,
   proof of receipt, inspection reports, photographs and your method of calculation.
3) Our receipt of 432,000 baht is a partial payment and not payment in full. We reserve
   the right to claim the balance of 48,000 baht, default interest and our other rights,
   including our reservation under section 381.
4) We will not sign any reconciliation or receipt until we have reviewed the documents in item 2.

We are available to meet within ____ days.

If you accept that some items are true, say so item by item, for example admitting a 2-day delay on the actual record while disputing the penalty amount and the other allegations. A partial, evidenced admission makes your position more credible in negotiation.

5. Reconciliations and paid-in-full receipts: what to watch

Business owners are usually asked to sign one of three things: a debt reconciliation, a receipt saying "paid in full", or a settlement agreement. Each may later be cited as your acceptance of the deducted figure and your loss of the right to claim the balance.

• Do not sign at once. Read every line, especially "paid in full", "no further claims" and "waiver".
• Change it to a partial receipt. If you must sign so the customer's accounts system can process it, add: "partial payment received; excludes the deducted amount, which is in dispute; all rights reserved".
• Reserve penalty rights. If you are the one with a penalty claim against the customer, such as for late payment, you must reserve it at the time of acceptance under section 381 paragraph 3.
• Use the same wording on every channel. Do not reply "OK" in a chat, which may be read as acceptance. For electronic evidence, see electronic signatures in company contracts.

If the customer says it will pay the rest only if you sign a paid-in-full document, weigh faster cash against the rights you lose, and negotiate the wording first. Do not decide from urgency alone.

6. Tax and documents when an amount is deducted

This is only a general outline. The details depend on the type of income, your VAT status and how the transaction is booked, so have your accountant or tax adviser review it before you issue any document.

• Credit note. A VAT-registered operator may issue a credit note where the price is reduced or there was an error in the goods or service, on the grounds set out in the Revenue Code. A customer deducting a penalty or damages that you still dispute does not necessarily mean the price has been reduced. Do not issue a credit note merely to make the figures match what the customer transferred, because that document would be evidence that you agreed to reduce the price.
• Withholding tax. A corporate customer usually withholds tax from what it pays and gives you a certificate. Check that the certificate matches the amount the customer actually paid and the amount you treat as still owing. If the figures differ, record the reason.
• Bookkeeping. An amount deducted but disputed should be recorded as a disputed receivable, not written off as bad debt or treated as paid, until the matter is agreed.
• Invoice and supporting records. Keep the original invoice, the payment slip, your dispute letter and the customer's reply together. Once the final figure is agreed, issue whatever adjustment document is needed to match that agreement.

7. Negotiation and what to do if there is no agreement

The usual route, from lightest to heaviest:

1. Meet with the documents. Take the table from section 2 and go through it item by item. The result should be a meeting note that both sides confirm.
2. Offer a partial settlement. For example, concede some items so the customer pays the rest immediately, written as an agreement stating which issues are settled and which are not.
3. A lawyer's demand letter. Where the customer is silent or has no reasoned basis. See demand letters and formal notices.
4. Mediation or arbitration. If the contract provides for it, follow the stated procedure. See alternative dispute resolution.
5. Litigation and enforcement. When nothing else works. See debt collection and enforcement. The result depends on the evidence and the court's discretion, so do not assume you will recover the full sum.

Meanwhile, watch the limitation periods and the time limits in the contract, such as the period for notifying defects or for bringing a claim before the right lapses.

8. Checklist when a customer deducts from its payment

The allegation

• You can state what the customer says you did wrong, and under which clause or purchase order
• You have checked the due date and the actual delivery date against delivery notes and transport records
• You have checked whether the customer reported defects within the period set by the contract

Evidence of loss

• You have requested the loss statement, photographs, inspection reports and the method of calculation in writing
• You have checked whether the loss came from you or from the customer (section 223)
• You have checked whether the figure is a normal loss or a special circumstance you could have foreseen (section 222)

The contract terms

• You have read the penalty clause, cap, notice procedure and any right to deduct
• You have checked whether the documents conflict, such as a purchase order against a quotation
• You have checked whether a penalty right was reserved at the time of receipt (section 381 paragraph 3)

Replying and signing

• You have sent a written dispute and reservation of rights
• You have not signed a reconciliation, paid-in-full receipt or settlement before checking the wording
• You have kept the evidence of the partial payment, with its date and amount

Tax and accounts

• You have consulted your accountant before issuing a credit note
• You have checked the withholding tax certificate against the amount actually paid
• You have recorded the deducted amount as a disputed receivable

Further reading

• Preparing a response to a breach-of-contract allegation letter — when the customer's allegation arrives as a formal letter
• Unpaid invoices from business customers — chasing the part the customer has not paid
• Contractor retention money not returned — where the employer withholds or keeps retention money
• MSA and SLA monthly service contracts — service credits and SLA-based penalties
• Quotation and purchase order with conflicting terms — which terms apply when the two sides' documents conflict
• Customer not signing acceptance and you cannot invoice — evidence of delivery and acceptance
• Debt collection and enforcement — when negotiation fails

A customer deducting from its payment does not mean you have to accept it, but you should not stay silent either. Separate the allegation, the evidence and the contract terms, then reply in writing with your rights reserved before agreeing any figure.

We help review penalty clauses, prepare letters disputing the deduction and reserving rights, check the wording of reconciliations before you sign, and negotiate or take further steps if there is no agreement. For an initial consultation, call +66 92 254 2045 or send us the details. See also demand letters and formal notices and alternative dispute resolution.

This guide is published by Suwanvara Law Firm — a Khon Kaen law firm established in 1986. General information only, not legal advice on a specific matter.